Fri Nov 26th, 2010 at 06:32:54 AM EST
This may be the best summary of the conventional wisdom I've seen, from Dan O'Brien, the economics editor of the Irish Times:
MANY SERIOUS people, in Ireland and elsewhere, have reached the conclusion that the Irish State cannot support the debt burden it has taken on.
Flowing from this conclusion comes the view that a portion of that debt must be defaulted on. The most obvious and frequently mentioned portion of that debt that advocates of default point to are monies lent to Irish banks, including senior bonds.
There are very powerful arguments to support the default view, and the strongest argument against it, from Irelandís perspective, evaporated last week Ė that argument was that any default on bank bonds would cause lenders to stop giving money to the Government to fund its deficit. That has now happened anyway.
It is no longer in Irelandís narrow national interest to prevent senior bondholders from suffering the consequences of their own bad judgement.
But this is very unlikely to happen, in the short term at any rate. That is so because a consensus exists among European policymakers regarding the extremely weak and fragile state of the Continentís financial system.
It has been based on a view that the system might not survive the direct and indirect effects of a default shock Ė the direct effect would be tens of billions of losses distributed across the system and the indirect effect would be panic as other bondholders realised that their government-backed protection had been removed.
This consensus is also informed by how, in hindsight, the US authorities grossly underestimated the effects of allowing Lehman Brothers to default 26 months ago; by how Europeís financial system continues to function owing only to massive government support; and by the fear that there may not be enough additional government resources to keep the system standing in the event of another shock.
Thus, no defaults are permitted, leading to all the bizarre events we're seeing.
I really don't think this can possibly work - there's only so many fingers you can stick in the dam before you have to just evacuate the village and let the water go.
Update [2010-11-26 6:51:35 by Colman]: Apparently, Spanish radio, quoting FT.de, is saying that the ECB is pushing Portugal to accept a bailout. WTF? More in comments Ö